What Is Runoff Insurance?
Runoff insurance is an insurance policy provision that covers claims made against companies that have been acquired, merged, or have ceased operations. Runoff insurance, also known as closeout insurance, is purchased by the company being acquired and indemnifies—exempts from liability—the acquiring company from lawsuits against the directors and officers of the acquired company.
KEY TAKEAWAYS
- Runoff insurance protects an acquiring company from legal claims made against a company being acquired or a company that has merged or ceased operations.
- A runoff policy applies for a certain period after the policy is active acting as a claims-made policy rather than an occurrence policy.
- Runoff policies are similar to extended reporting period provisions except they apply to multi-year periods, not just one year.
Understanding Runoff Insurance
Acquiring a company means taking possession of its assets, but also its liabilities, including those only be discovered in the future. Obligations arise for many reasons. Third parties may feel that they were not treated fairly in contracts. Investors may feel upset with how the previous directors and officers ran the business. Competitors may claim infringement of intellectual property rights. An acquiring company might demand that the company being acquired purchase runoff insurance to protect itself from these liabilities.
A runoff policy is a type of claims-made policy rather than an occurrence policy. The difference in policy type is because the claim may be made several years after the incident that caused damage or loss, and occurrence policies provide coverage only during the period that the policy was active. The length of the runoff policy, referred to simply as the “runoff,” is typically set for several years after the policy becomes active. The provision is purchased by the acquiring company, and the purchase funds are often included in the acquisition price.
Professionals may also purchase runoff insurance to cover professional liabilities that occur after a business has closed. For example, a physician who closes their private practice may purchase runoff insurance to protect themselves from claims filed by previous patients. This type of policy is typically renewed until the statute of limitations on filing a claim has passed. If the business continues to offer services, its policies typically extend indemnification making the purchase of a runoff provision unnecessary.
Important: The following insurance policies should have a runoff provision: directors and officers (D&O) insurance, fiduciary liability insurance, professional liability (E&O) insurance, and employment practices liability (EPL) insurance.
Runoff Insurance Example
Consider a hypothetical runoff policy written for a term between Jan. 1, 2017, and Jan. 1, 2018. In this situation, coverage will apply to all claims caused by wrongful acts committed between Jan. 1, 2017, and Jan. 1, 2018, that are reported to the insurer from Jan. 1, 2018, to Jan. 1, 2023. That is, the five years immediately following the end of the policy term.
Special Considerations
Although runoff insurance provisions function similarly to extended reporting period (ERP) provisions, there are several differences. First, ERPs are typically only for one-year terms, whereas runoff provisions normally encompass multi-year periods. Second, ERPs are frequently purchased when the insured individual switches from one claims-made insurer to another, whereas runoff provisions are used when one insured is acquired by or merges with another.
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